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The Chrysler bankruptcy

This is not a post about how Chrysler might work going forward, nor a post about how dastardly the hold-outs are.  This is a post about the distribution of haircuts and the move from White House-led negotiation to bankruptcy court.

There are broadly four groups of creditors:  The (sole remaining) shareholder, the union/pension-fund, the bond holders and the US government.

Clearly the shareholder should be wiped out.  The question is how much of a haircut everybody else should take.

I believe that by law, the US government would take the smallest haircut (get the largest fraction of their money back) as they’re super-senior, then the bond holders in decreasing order of seniority and the union/pension fund should get the biggest kick in the teeth.  The hold-outs were secured creditors, which means that if the company is liquidated they get a pretty senior claim on the proceeds.

[Update: Duh.  The government isn’t a super-senior bond holder, it’s a preferred share holder, which means that it’s claims, in principle, ought to be subordinate to the bond holders]

As I understand it, the deal on the table had the order differently.  The unions were getting back something like 60c on the dollar, the government 45c on the dollar and the bondholders 25c on the dollar (those numbers are made-up, but indicative).

That conflict between what would normally happen and the deal on offer was what gave rise to this sort of comment from Greg Mankiw:

The Rule of Law — Not!

Via the WSJ, here is the view from a “secured (sic) creditor” of Chrysler:

“Like many others I made the mistake of buying what I believed was ‘value,'” Mr. Gwin says, adding that investors who bought at the time believed the loans were worth more than their market price. “We did not contemplate having our first liens invalidated by a sitting president,” he adds.

As the President intervenes in more and more industries, a key question is how he does it and what he is trying to achieve. Is he trying to reorganize insolvent firms while, as much as possible, preserving the rights of stakeholders as established under existing contracts? Or is he trying to achieve a “fair” outcome as he judges it, regardless of preexisting rules and agreements? I fear it may be the latter, in which case politics may start to trump the rule of law.

Mankiw has an uncanny ability to irritate me at times and although he has a bloody good point, even a vitally important point, this post did irritate me because I suspect that most bankruptcy arrangements aren’t fair, for a few reasons:

First, bond-holders, like equity holders, are ultimately speculators.  We differentiate the seniority of their claims legally, but the fact is that a guy holding a Chrysler bond is just as much of a punter as the dude holding one of the shares.  They (presumably) had the same access to information about Chrysler’s future and they (hopefully) both knew that their investment came with risk.  The idea of one subset of one factor of production being largely protected from the risk of the company’s failure is silly.

Second, employees are not speculators in the same way that the providers of capital are.  The cost of taking your money out of a company’s bonds or shares and moving it to another company is negligible.  The cost of taking your labour out and moving it to another company is significant.  At the very least, you are often geographically tied down while your money is not.  Therefore the socially optimal decision would help insure the employees against the risk of the company failing but leave the capital to insure itself.  Since US unemployment benefits (the public insurance framework) is so measly, it seems reasonable to grant employees partial access to the assets of the company.

Third, in every company to some extent (although varying depending on the industry), the employees are the company.  At an extreme, ask what a law firm would be worth if you fired all the lawyers.  Therefore, even if labour were perfectly mobile, there is a game-theoretic basis for giving the employees a stake in the game:  Principal-Agent problems exist all the way down to the floor sweepers.  This is an argument for German-style capitalism where the workers are also minority shareholders.  You might argue against workers’ representatives on the board of directors, but I do think they ought to have a share holding.

Fourth, even if all of the above balanced out to zero, there might (might!) be be beneficial social welfare to ensuring that the company is an ongoing concern rather than liquidated.  When they pushed Chrysler into bankruptcy, the hold-outs were doing so because they would get more money under liquidation than the deal on the table.  If there is a benefit to social welfare in keeping the company open, there ought to be a way to force the bond-holders to take a hefty haircut rather than liquidating the assets, even – and this is where Professor Mankiw might really get upset – if it wasn’t Pareto improving (the needs of the many …).

Nevertheless – and this is why Mankiw managed to get under my skin on this occassion – I am glad that Chrysler has gone into bankruptcy.

I am glad because even though I largely agree with the White House’s proposal, and even if my four points are all true, it is not the job of the executive to be making these decisions.    There are entire institutions set up for it.  The bankruptcy courts and the judges who preside over them specialise in this stuff.  By all means the White House might make a submission for consideration (as the executive of the country, not just as a stakeholder), but it should be up to the judge to decide.

I suspect, or at least like to imagine, that Barack Obama knows all this already (he is a constitutional lawyer, after all) and that he pushed the negotiation down the path it has taken because politically he needed to be seen to be trying to “save” Chrysler from bankruptcy and economically ne needed to avoid the market turmoil that would have ensued from a sudden move to bankruptcy rather than the tortuously gradual one we have seen.

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More on Northern Ireland vs. Israel/Palestine

After my last post on this, I’ve been listening to the responses of Sinn Fein to the recent murder of two guys in the British Army by the “Real IRA” and, believe it or not, thinking about the parallels with Islam.  There’s nothing particularly original in my thoughts, but I thought I’d put them up here anyway.

a) I think that many beliefs – and often more importantly, many practices that are based on beliefs – change only very slowly over time. Often, the practices retain importance even when the beliefs they’re based on have long since evaporated.

b) What’s more, beliefs – and practices – change much more across generations than within them, so that once you reach your first full set of beliefs at around the age of 20, they’ll change extremely slowly, if at all, over the rest of your life. Real change comes when children choose to differ from their parents. This sort of thing is not particular to ideas of religion or morality. There’s been some recent work showing that people’s attitudes to risk-taking are essentially shaped when they’re young.

c) When somebody makes the discrete choice to turn to violence, it’s common to conclude that they are an inherently violent person (or, in the case of the radical Islamist stuff, operating under inherently violent beliefs). Contrary to this, I suspect that the violence emerges at a point of inflection (a “tipping point”) in how they cope with perceived opposition to their beliefs. It doesn’t matter if their beliefs are constant but their perception of society’s opposition to them is changing, or if their beliefs are changing and their perception of society is constant. At some point, the distance between their private beliefs and their perception of what the world is imposing on them becomes great enough for them to break from their previous behaviour and move to something disjointedly different. Violence from radical Muslims is one example, but so is violence from Republicans in Northern Ireland, or violence from working-class gangs in Northern England in the early ’80s.

d) There is an important difference between the distance between two two sets of beliefs and the level of opposition between them. Opposition might be more likely to increase when the beliefs are a long way apart, but it doesn’t necessarily have to. It is the sense of opposition that leads to the disjoint jump into violence.

e) Therefore, what brings about peace in the long term is long periods of calm. Calm with grumbling, certainly, but calm. The newly migrant family might stick out like a sore thumb, but so long as they are tolerated and they tolerate their new home, then their children (or their grandchildren) will eventually conform to the society they find themselves in.

I think the greatest victory in Northern Ireland was in convincing people to put down their guns for a while. The details of any particular agreement are less important, because the real details will emerge from the ground up as the people who had previously been spitting in each other’s faces find themselves (awkwardly, painfully) interacting with each other instead. Yes, the details of the agreement are what helped put the guns down in the first place, but that was all.

I read somewhere that before the recent crap in Gaza, Hamas had offered Israel a 30-year truce. Not a peace agreement. Not an acknowledgement of Israel’s right to exist. Just a truce. If it’s true, I think Israel made a mistake in not accepting it.

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Article Summary: Economics and Identity

You can access the published paper here and the unpublished technical appendices here.  The authors are George Akerlof [Ideas, Berkeley] and Rachel Kranton [Duke University].  The full reference is:

Akerlof, George A. and Kranton, Rachel E. “Economics and Identity.” Quarterly Journal of Economics, 2000, 115(3), pp. 715-53.

The abstract:

This paper considers how identity, a person’s sense of self, affects economic outcomes.We incorporate the psychology and sociology of identity into an economic model of behavior. In the utility function we propose, identity is associated with different social categories and how people in these categories should behave. We then construct a simple game-theoretic model showing how identity can affect individual interactions.The paper adapts these models to gender discrimination in the workplace, the economics of poverty and social exclusion, and the household division of labor. In each case, the inclusion of identity substantively changes conclusions of previous economic analysis.

I’m surprised that this paper was published in such a highly ranked economics journal.  Not because of a lack of quality in the paper, but because of it’s topic.  It reads like a sociology or psychology paper.  99% of the mathematics were banished to the unpublished appendices, while what made it in were the justifications by “real world” examples.  The summary is below the fold … Continue reading “Article Summary: Economics and Identity”

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One of the challenges in negotiation for Israel/Palestine

There’s a perennial idea of proposing Northern Ireland as a model of how progress might be achieved in the fighting between Israelis and Palestinians.  After reading this recent posting by Megan McArdle, one of the difficulties in such an idea becomes plain.

In Northern Ireland, both sides had moral, if not logistical, support from larger powers that were themselves allies.  So while the nationalists found it difficult to trust the British government, they would generally trust the US government, who in turn trusted the British government, while the same chain applied in reverse for the loyalists.

By contrast, while Israel receives moral and logistical support from the USA, none of America’s close allies really comes close to giving the Palestinian cause at large, let alone Hamas in particular, the sort of tacit support that America gave the Irish nationalists.

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The Transparent Society

During the recent US presidential election, California voted to change it’s state constitution to exclude gay couples from being married (proposition 8). Prior to the election, the Californian supreme court had overturned a regular law that banned gay marriage as being unconstitutional. Thus the (successful) move by social conservatives to change the state’s constitution.

Via Andrew Sullivan (1, 2, 3, 4) and in a demonstration of the move towards David Brin’s “Transparent Society,” I give you http://www.eightmaps.com where you can see the names, addresses, employer and amount donated of everybody that gave money to the proposition 8 campaign, all arranged on a Google Maps mash-up.

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The cantankerous nature of Hamas

Jeffrey Goldberg writes in the NY Times:

What a phantasmagorically strange conflict the Arab-Israeli war had become! Here was a Saudi-educated, anti-Shiite (but nevertheless Iranian-backed) Hamas theologian accusing a one-time Israeli Army prison official-turned-reporter of spying for Yasir Arafat’s Fatah, an organization that had once been the foremost innovator of anti-Israeli terrorism but was now, in Mr. Rayyan’s view, indefensibly, unforgivably moderate.

I don’t want to take a side here, just marvel at the incredible ability of the human mind to twist itself into such knots of conspiracy and ideology.

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Power proportional to knowledge

Arnold Kling, speaking of the credit crisis and the bailout plans in America, writes:

What I call the “suits vs. geeks divide” is the discrepancy between knowledge and power. Knowledge today is increasingly dispersed. Power was already too concentrated in the private sector, with CEO’s not understanding their own businesses.

But the knowledge-power discrepancy in the private sector is nothing compared to what exists in the public sector. What do Congressmen understand about the budgets and laws that they are voting on? What do the regulators understand about the consequences of their rulings?

We got into this crisis because power was overly concentrated relative to knowledge. What has been going on for the past several months is more consolidation of power. This is bound to make things worse. Just as Nixon’s bureaucrats did not have the knowledge to go along with the power they took when they instituted wage and price controls, the Fed and the Treasury cannot possibly have knowledge that is proportional to the power they currently exercise in financial markets.

I often disagree with Arnold’s views, but I found myself nodding to this – it’s a fair concern.  I’ve wondered before about democracy versus hierarchy and optimal power structures.  I would note, however, that Arnold’s ideal of the distribution of power in proportion to knowledge seems both unlikely and, quite possibly, undesirable.  If the aggregation of output is highly non-linear thanks to overlapping externalities, then a hierarchy of power may be desirable, provided at least that the structure still allows the (partial) aggregation of information.

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Needing a visa to visit America

Australia, like most of Western Europe and a few other countries, is on America’s “visa waiver” programme, which lets people travel to the USA for up to 90 days at a time without first applying for a visa, although the US can still deny entry to anybody that doesn’t answer the immigration official’s questions to their satisfaction.

By comparison, Australia requires that all visitors from everywhere except New Zealand have a visa. It’s a staggeringly simple and not overly expensive process that can happen online, but it’s a visa-requirement nonetheless.

It looks like the US is moving to an Australian-style system. They’re still calling it a “visa waiver,” but the requirement that I register before entering the US and that they reserve the right to deny my registration seems a lot like a visa to me. From the article:

Passengers travelling to the United States from countries whose citizens do not need visas must register online with the US government at least 72 hours before departure [from January 2009]

…

Although the new rule requires 72 hours advance registration, it will be valid for multiple entries over a two-year period. The rule will only apply to citizens of the 27 visa waiver programme countries

…

A Homeland Security official said the new measure would require the same information that passengers now have to include on the I-94 immigration form they must fill out before entering the US. He said Australia has been using a similar system for several years.

Presumably this means that the US will be more likely to start adding the newer members of the EU to the “visa waiver” programme.

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Four techniques of public policy

Suppose you have a situation where individual choices are suboptimal, both for that individual and for the group as a whole.  Exactly why the individual makes suboptimal choices isn’t immediately relevant for the moment.  It seems to me, that there are four broad approaches to “solving” this problem: a) an engineering approach; b) a government mandate; c) economic incentives; and d) a psychological approach.  The four approaches are not mutual exclusive and can even overlap, but they each bring a different mindset to the problem.  All four approaches can be taken to an absurd extreme.

To explain each of the four, an (admittedly pretty graphic) example may be useful.  Men seem, in general, to have a habit of spillage at public urinals – pee goes on the floor instead of the urinal.  This induces both private costs (increased health risks and the ‘ick’ factor of negotiating another guy’s floor-pee) and public costs (increase cleaning costs).

  • An engineering approach would be to design a better urinal to minimise spash-back.  An extreme engineering approach would not only do this, but also include sensors to detect when urine falls outside the catchment area and then activate an automatic (i.e. robotic) cleaning system.
  • A government mandate would make it illegal to spill your pee on the floor.  How extreme this is would depend on the enforcement mechanism.  A light-handed approach would pass the law and then do nothing to enforce it, similar to jay-walking.  A heavy-handed approach would hire a cop to occasionally watch men pee and arrest them if they spill, similar to most countries’ drug policy.  An extreme approach would have a government agent hold your penis to make sure that you don’t spill, similar to the Australian government’s enforcement of mandatory superannuation.
  • An economic incentive would impose a fine on men for spilling and/or give them a bonus payment for not spilling.  How extreme this measure is would depend on the size of the fine or the bonus.  Because this also has a need for enforcement (government-implemented or government-guaranteed), this can be thought of as a market-oriented government approach.
  • A psychological approach would seek to reframe the issue to influence the way that men make their choices.  For the urinal, it could be to make use of the fact that if you paint a fly in the urinal at the spot that minimises splash-back, the visual cue will cause men to aim at it and overall spillage will fall.  My mother did something similar when I was a kid.  She had five teenage boys living under her roof and not even making us clean the toilet seemed to stop the mess, so she put a ping-pong ball in the toilet (because it’s so light, it won’t flush down) and told us to aim at it.

So what’s my point?  Just this:  most people tend to focus on just one of the four approaches and think that it is the best way to solve every problem, when the truth is that different problems call for different responses and that the best strategy will usually employ several approaches.  In the case of spilling urine, the best strategy is probably a combination of an engineering and psychology, but in others a different combination may be optimal.  Don’t always think that your favourate approach is the best or only one.

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Farm subsidies promote terrorism

Well, maybe not directly, but it bears thinking about. It’s not a new idea, either, but I thought I’d put it out there anyway …

US and European farm subsidies artificially suppress world crop prices by causing American and European farmers to produce more than they profitably otherwise could. By the World Bank’s estimates, the prices of course grains, rice and wheat would rise by between 4% and 7% relative to other prices if all subsidies and other impediments to trade were removed (hat tip: Dani Rodrik).

That means that farmers in places like Afghanistan turn to other crops like poppies (for heroin). Since drugs are illegal, the farmers can only sell their crops through black (well, in Afghanistan, grey) markets that are controlled, America tells us, by people who support and funnel profits to the Taliban and al-Qa’ida.

Those Afghani farmers don’t really care what they grow. They just want to make a profit, like anybody else. How do we know this? Because when the price of crops goes up for other reasons, they happily started switching to planting wheat:

In parts of Helmand Afghan farmers are this year sowing wheat instead of poppy – not because they have suddenly been converted to the argument that producing heroin is not in the national interest.

Market forces have been the deciding factor – with wheat prices doubling in the past year, and the street price of heroin falling, it is now more cost effective to grow wheat.

So there you have it. If America was serious about fighting drugs and terrorism, it would cut it’s farm subsidies.